There can be no doubt that the Bank of England’s flagship Funding for Lending Scheme (FLS) has proved a success by stimulating the supply of mortgages and has help drive down lending rates in the mortgage market. Before FLS, two and five-year fixed-rate deals had been about 1 per cent higher than they are now and in less than a year after launch in July 2012, the UK central bank lent £17.6bn to 28 banks at interest rates as low as 0.75 per cent. In total, just over £23bn has been lent under the scheme since it started 17 months ago. In turn, monthly mortgage approval rates are now a third higher than three years ago. In fact, in the third quarter of 2013, there were 170,700 house purchase loans advanced, worth a total of £27.1bn, which is the highest quarterly figure since the fourth quarter of 2007. But those quarterly lending figures are telling, since it is clear that the FLS element is still only a small, though not insignificant portion, of monthly lending by banks and building societies.
This boost to mortgage lending also needs to be put into some context in terms of the size of the market. According to the Council of Mortgage Lenders, there are currently 11.3m mortgages outstanding in the UK and the total loan book is worth over £1.2 trillion. The £23bn drawn by banks under FLS is therefore only a very small proportion of the outstanding UK mortgage book.
Moreover, extrapolating the third quarter CML figures across a calendar year would only mean around 700,000 home purchase loans, around six per cent of the total mortgages outstanding. Those transactions are not going to dry up if mortgage rates edge up as a result of the withdrawal of FLS from the start of next year especially since conditions in the wholesale money markets have improved significantly in the past 18 months which means lenders that have been tapping FLS do have an alternative source of funding. It’s also worth noting that mortgage rates had bottomed out in any case, irrespective of the stimulus of the FLS, and with the economy recovering it was only a matter of time before the rock bottom rates on offer would start to climb. And the cheap funding is unlikely to dry up overnight since banks still have a sizeable proportion of their FLS allowance unused and which could be deployed to support mortgage lending, assuming draw down before the end of January.
Availability not affordability is the issue
In any case, the key issue facing the housing market was not the affordability of mortgages, but the availability of higher loan-to-value loans. For instance, the September first-time buyer mortgage lending figures show that the average loan-to-value ratio was 80 per cent on the 23,600 loans taken out during the month (and worth a total of £3.3bn), but only 11.5 per cent of the average borrower’s net disposable income was going on interest payments and less than 20 per cent including capital.
That’s why the boost from the second part of the Help-to-Buy scheme, which was launched recently and becomes fully operational next month, is likely to make the housing market more accessible for first time buyers who don’t have a large deposit rather than the FLS where there was every incentive for mortgage lenders to cherry pick applicants applying at low loan-to-value ratios, which required less bank capital to back these loans. That’s because the return on capital employed is much higher by offering a low loan-to-value mortgage rather than a high one which needs far more bank capital to back it. On a risk reward basis, it’s better business for the bank to take on lower low-to-value mortgages since default risk is lower too which means that impairment charges are less likely to prove a drag on profits and credit quality.
To recap, the second phase of the Help-to-Buy scheme offers all loan applicants taxpayer-backed mortgage guarantees on homes worth up to £600,000 and loans worth up to 95 per cent of a property's value. In my opinion, the withdrawal of FLS shouldn't make any difference to loans offered through the Help-to-Buy mortgage guarantee scheme which is backed by substantial government guarantees. That’s because banks and building societies will still be able to access a taxpayer-backed guarantee on 95 per cent mortgages, but cheap, high loan-to-value mortgages outside the scheme are likely to disappear if lenders have used FLS to back them.
The withdrawal of FLS also means that widespread expectations of a new house price boom in the rest of the country are being dampened down at an early stage. That’s no bad thing since it stops the current rise in house prices becoming self-fulfilling and reduces the risk that the boom in London and the south east, in particular, could lead to a bubble. Moreover, it also signals that the Bank of England is becoming concerned about the risk of the housing market being pumped up too much, and is prepared to take action. It also means that transactions can take place in a market that is not tearing away, as has been the case in London all this year, which sets the scene for a more stable market.
On solid foundations
As I mentioned at the start of this article, last week I advised buying shares in the housebuilders, primarily to benefit from a seasonal first quarter effect whereby in the past 34 years the sector has risen almost 90 per cent of the time and generated a double digit return in the process ('As safe as houses', 27 Nov 2013). I have little reason to think that this seasonal trend will not repeat itself since we are guaranteed further good news from the housing market, both in terms of sales for home builders, lending data for mortgage approvals and price data from organisations that track the market.
It is also reasonable to assume that given the momentum in private residential sales and prices, earnings upgrades could be in the offing as soon as the nine FTSE 350 housebuilders start releasing their pre-close trading statements and financial results from the end of January onwards. On valuation grounds the sector is not overvalued and balance sheets and land banks are both robust. This week’s share price weakness is, in my view, a buying opportunity and one that by the end of March is likely to once again bring financial rewards.
In response to recent newsflow, I am currently working my way through a long number of updates including the following recommendations: Bezant Resources (BZT), Crystal Amber (CRS), API (API), WH Ireland (WHI), Dragon-Ukrainian Properties & Development (DUPD) and Conygar (CIC).
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In the past fortnight I have published articles on the following 19 companies or trading strategies:
■ Trifast ('A bolt-on purchase', 18 Nov 2013)
■ Global Energy Development ('Awaiting pay dirt', 19 Nov 2013)
■ Entertainment One ('Blue sky territory', 20 Nov 2013)
■ Marwyn Value Investors ('Blue sky territory', 20 Nov 2013)
■ Polo Resources ('Unloved and undervalued', 21 Nov 2013)
■ Heritage Oil ('Bargain shares update', 21 Nov 2013)
■ Eros ('Conundrum to solve', 25 Nov 2013)
■ Amino Technologies ('Conundrums to solve', 25 Nov 2013)
■ Town Centre Securities ('Time to make friends up north', 25 Nov 2013)
■ Raven Russia ('Cash in on a Russian property play', 25 Nov 2013)
■ Sanderson ('An app investment', 26 Nov 2013)
■ Equity market strategy ('Betting on a Christmas rally', 26 Nov 2013)
■ Eurovestech ('Kalibrate to fuel Eurovestech', 27 Nov 2013)
■ Housebuilders trading strategy ('As safe as houses', 27 Nov 2013)
■ Bovis Homes ('Bovis poised for chart break-out', 28 Nov 2013)
■ Netcall ('Dial into cloud-based profits', 28 Nov 2013)
■ Daejan ('Bargain basement prime property', 29 Nov 2013)
■ PV Crystalox Solar ('Cash rich and undervalued', 2 December 2013)
■ Pilat Media Global ('Bumper upgrades for software maestro', 2 December 2013)
